The corporate board is commonly seen as a crucial governance device that operates to both monitor corporate management and provide strategic advice. Recent corporate governance research has discovered a broad range of evidence of internal board monitoring and advisory activities; but relatively little on the impact of the board’s interactions and connections with different external agents on firm value and corporate decisions. Yet, board members are typically experienced and powerful businessmen, and well embedded in the center of important business and social networks. Does it matter?
Yes, substantially. In our recent paper “Directors as Connectors: The Impact of the External Networks of Directors on Firms”, we focus on the role of corporate directors as connectors to external environments, and use a precise method to quantify the impacts they have on firm value and decisions.
Typical studies that compare firms with a varying extent of director connections cannot credibly distinguish the causal direction of the relationship between connections and performance. Our method makes use of a “natural experiment” that substantially shocks connections by directors, in order to claim that the subsequent effects on corporate outcomes are truly caused by directors’ connections.
The natural experiment we use is tight contests for governorship across American states. Tight elections are unpredictable, and there are practically little difference between winners and losers, in the statistical sense. Thus, comparing firms with directors connected to either side of a tight election produces the best estimates of the causal impacts of directors’ connections to governors on corporate value and decisions.
We find that just after Election Day, local firms connected to the gubernatorial winner saw market capitalisation gains of 4.1% above local firms connected to a closely defeated contender – amounting to an increase in firm value of $212 million for the average firm in the study’s sample of 516 publicly listed U.S. companies (connected to 483 directors), with an average market capitalisation of $5.16 billion and 13,830 employees.
The effect on stock value persists over time. One year after the election, governor-connected firms still enjoy stock returns that are 13 per cent higher than firms connected to the losing candidate. After three years, the gap widens to a whopping 22 per cent.
These various benefits are particularly concentrated on connected firms, rather than spread to other companies in the same industry. They are particularly strong in states notorious for corruption, under stricter economic regulations, and with a larger employment share in the public sector. The findings are consistent with firms and governors able to make mutually beneficial deals, although we cannot make any claim of wrongdoings.
In what aspects do firms reap benefits from directors’ connections to governors? The bulk of evidence comes from direct benefits from the state government. Firms connected to the winning gubernatorial candidate are 5.1 percent more likely to benefit from any form of state subsidies, and in particular 5.6 percent more likely to receive tax credits, amounting on average $330,000 higher than firms connected to the loser in the four years following the election. As expected, there is no difference regarding access to federal subsidies between the two types of firms.
One year following the election, the average firm with directors connected to a narrowly winning candidate obtained $233 million in loan facility above the average firm connected to the loser, and after three years enjoy interest rates that are 0.4 per cent lower on its entire borrowing. They also increase investment by 1.1 percent, employment by 1.7 percent, and produce 1.7 percent higher returns on assets.
The study focuses on educational links between directors and politicians who graduate within a five-year difference from the same university campus with the same degree. Furthermore, we only consider directors of firms in the election state, or within 500 miles of that state’s capital. Educational links are readily verifiable, and are broadly representative of directors’ social ties. The value of those connections is reinforced when directors and politicians have the occasion to attend the same alumni reunion (which varies by university).
So who are those connectors connected to? The sample of candidates involved in tight gubernatorial contests includes many prominent politicians, such as New Jersey Gov. and presidential candidate Chris Christie (University of Delaware), Ohio Gov. and presidential candidate John Kasich (Ohio State University), and former Arizona Gov. (and later Secretary of Homeland Security) Janet Napolitano (Santa Clara University and the University of Virginia).
Our study brings clear evidence of average benefits to firms whose directors are connected to governors, and the findings are consistent with the view that firms benefit from deals brokered with powerful politicians, and not from better adapted policies. However, it is not possible to identify the gains in each specific case.
In his famous best-seller The Tipping Point, the popular writer Malcolm Gladwell extols the qualities of Connectors as “[…] by having a foot in so many different worlds, they have the effect of bringing them all together.” Our study thus highlights the role of directors as Connectors, who help connect the corporate board, distinguished by Eugene Fama and Michael Jensen as “the common apex of the decision control system” in firms, to the local world of politics, and bring specific benefits to the firm in the process. Such a role of directors must not be ignored.
The preceding post comes to us from Quoc-Anh Do, Associate Professor of Economics at the Department of Economics and the LIEPP (Interdisciplinary Center for Evaluation of Public Policies) at Sciences Po, Yen-Teik Lee, assistant professor of finance at Shanghai University of Finance and Economics, and Bang Dang Nguyen, a University Lecturer in Finance (tenured) at the University of Cambridge Judge Business School. The post is based on their paper, which is entitled “Directors as Connectors: The Impact of the External Networks of Directors on Firms” and available here.